Fitch Affirms Loma Linda Univ Med Ctr (CA) Rev Bonds at 'BBB-'; Outlook Stable

Fitch Ratings has affirmed the 'BBB-' rating on Loma Linda University Medical Center's (LLUMC) outstanding debt, which is listed at the end of this press release.

The Rating Outlook is Stable.

SECURITY

The bonds are secured by a gross revenue pledge and mortgage pledge of the obligated group (OG). In addition, LLUMC has a debt service reserve fund.

KEY RATING DRIVERS

PROVIDER FEE PROGRAM BUOYS RATING: LLUMC's profitability and cash flow are strong for the rating level and mainly driven by the net benefit from the state provider fee program. This revenue stream was just extended for another three years, which Fitch views favorably as it should give LLUMC additional financial cushion as it continues its strategic growth initiatives in building out its regional network, aligning with physicians, and implementing its electronic medical record platform (Epic).

REGIONAL GROWTH STRATEGY: LLUMC has been challenged by its unfavorable payor mix with over 30% of its gross revenues from Medi-Cal. In an effort to improve its payor mix and create additional referral relationships from a fast growing, favorable payor mix population in the Inland Empire, LLUMC has invested significantly in several facilities including a new hospital in Murrieta as well as some outpatient facilities in the service area. These facilities remain unprofitable; however, there is significant upside especially with LLUMC - Murrieta, which is located in an area that has historically had a significant amount of outmigration.

LOOMING LONG-TERM LIABILITIES: LLUMC's 10-year capital plan totals approximately $1.6 billion and includes LLUMC's seismic requirements as well as the buyout of an operating lease (which financed Murrieta [REIT financing]). Sources of funding include a mix of debt, cash flow, philanthropy and state funding. Near-term additional debt will likely be issued for the buyout of the operating lease with another debt issuance for seismic needs projected in 2016. Both of these issuances have not been incorporated into the rating at this time and the impact will be assessed as financing plans are finalized.

WEAK LIQUIDITY: LLUMC's balance sheet has historically been weak and there are various demands on liquidity including swap collateral posting requirements and exposure to risks related to its variable rate demand bonds (VRDBs). In addition, ongoing transfers to other related entities (physician faculty group) have suppressed liquidity growth.

RATING SENSITIVITIES

REIT BUYOUT FINANCING: LLUMC will likely issue additional debt on a non-obligated group basis for the REIT buyout within the next year. Fitch's analysis is based on the consolidated entity and Fitch will assess the impact on the rating when financing plans are finalized. Fitch believes there may be some additional debt capacity at the current rating level for this financing as debt service coverage ratios should not be affected, since debt service is expected to be less than the operating lease expense. However, if there is a material decline in debt service coverage levels, negative rating pressure could be warranted.

SEISMIC REQUIREMENTS ARE ONEROUS: LLUMC's projected capital plan is a concern as state seismic requirements will require the need for an additional sizeable debt issuance, which Fitch believes LLUMC has limited debt capacity for given its weak balance sheet. However, the timing to address the seismic requirements may be extended, which would be viewed favorably.

CREDIT PROFILE

LLUMC is an 881 licensed bed academic medical center located in Loma Linda, CA, 60 miles east of Los Angeles. LLUMC houses the nation's first hospital-based proton treatment center for cancer. LLUMC is the only member of the obligated group and includes four hospitals - University Hospital, Children's Hospital, East Campus Hospital, and the Heart and Surgical Hospital. Other non-obligated group affiliates include Loma Linda University Behavioral Medicine Center, Loma Linda University Children's Hospital Foundation, Loma Linda Healthcare Properties, LLUMC - Murrieta, and Loma Linda University - Urgent Care. The total system has 1,076 licensed beds. LLUMC accounted for 90.1% of total assets ($1.4 billion) and 89.6% of total revenues ($1.4 billion) of the consolidated entity in 2012 (Dec. 31 fiscal year end). Fitch's analysis is based on the consolidated entity, Loma Linda University Medical Center and Affiliates.

Fiscal 2013 Performance Below Budget

LLUMC has some cushion at its current rating level due to the significant benefit from the provider fee. In fiscal 2012, LLUMC had an operating income of $59 million (4.3% operating margin) compared to $94 million (7.3% operating margin) in the prior year. Through the nine months ended Sept. 30, 2013, operating performance is behind budget mainly due to Epic implementation operating expenses being approximately $15 million over budget. In addition, since LLUMC has significantly benefited from the provider fee, there has been an increase in the transfers to affiliates (below net income) to the faculty physician group. Transfers to affiliates totaled $21 million through the nine months ended Sept. 30, 2013 compared to $8.6 million in fiscal 2012 and $14 million in fiscal 2011.

Consolidated interim financials were unavailable; however, the medical center posted strong performance with a $69 million operating income (7.3% operating margin) through the nine months ended Sept. 30, 2013. Of the non-obligated affiliates, Murrieta has the most impact on consolidated performance and through the nine months ended Sept. 30, 2013, Murrieta had a negative $22 million bottom line. This has improved from negative $51 million in fiscal 2012 and negative $61 million in fiscal 2011. Murrieta's fiscal 2014 budget is still being finalized but the rate of the reduction in losses is expected to continue, which should be achievable given its strategy to further enhance service offerings as well as a focus on cost savings.

Major Beneficiary of Provider Fee

California enacted a hospital provider fee in 2010 to draw down additional federal funds for Medi-Cal services. Given LLUMC's high Medi-Cal load, LLUMC has been a major beneficiary of the program, which has boosted profitability. The 2010 provider fee (for the period April 2009 to December 2010) resulted in a net benefit of $85 million in fiscal 2010. Two subsequent periods were approved with a net benefit of $43 million in fiscal 2011, $63 million in fiscal 2012 and $74 million through the nine months ended Sept. 30, 2013. The provider fee was set to expire in December 2013 and was extended for a three-year period through December 2016. Fitch views this favorably as it should net LLUMC over $200 million.

LLUMC's operating performance without the provider fee is very weak and an improvement in LLUMC's operating performance without the provider fee would be viewed favorably. Given its high exposure to Medi-Cal, LLUMC is also reliant on disproportionate share funds, which has totaled approximately $30 million a year, and is projected to remain stable.

Significant Opportunity with Regional Growth Strategy

LLUMC's main credit strength continues to be its leading market share position and role as an academic medical center. LLUMC is the market share leader in its primary service area in the Inland Empire (San Bernardino and Riverside counties). It offers quaternary and tertiary services and has the only level-I trauma center and level-III neonatal intensive care unit in the service area. LLUMC's Medicare case mix index is very high at 1.9. LLUMC's market share totaled 10% in 2012 compared to the next closest competitor, Kaiser-Fontana, with 6% market share. Fitch expects market share to increase especially as LLUMC continues to capture outmigration from the Murrieta market.

Fitch believes LLUMC has a major area of opportunity with its investment in the Murrieta market. LLUMC opened its new 106 bed hospital in Murrieta in April 2011 in a market that has traditionally seen a lot of outmigration. Since its opening, volumes have continued to increase. The run rate of operating losses has decreased and there is significant population growth of a favorable payor mix in this region. LLUMC's ability to capitalize on this investment will be key to an improved overall financial profile of the system.

When the hospital was planned, it was initially intended to be a joint venture with physicians and the construction was financed through a real estate investment trust (REIT) at a cost of approximately $220 million. Due to provisions under the PPACA regarding physician ownership, LLUMC bought out the physician ownership in 2011. The facility is currently being leased under a 15-year term that expires in March 2026. LLUMC is in negotiations to buy out the lease and Fitch will assess the impact on the rating when financing plans are finalized.

LLUMC is also in discussions with other providers in the area to develop a regional accountable care network to collectively leverage the strengths of the individual providers to better provide care for the population it serves.

Large Capital Needs

LLUMC's capital needs total approximately $1.6 billion over the next ten years and are mainly driven by the state seismic compliance requirements, which would require the construction of two new patient towers including a new children's hospital. The funding sources are expected to include cash flow, additional debt, fundraising, and funds from Proposition 61 and 3 (voter-approved ballot initiatives for children's hospital construction).

LLUMC has until 2020 to meet the state requirements; however, management is confident that a further extension could be granted. Fitch would view a further extension favorably as it would give LLUMC some additional time to build up its balance sheet while the Murrieta strategy matures. LLUMC anticipates starting construction in 2015-2016 if a further extension is not granted.

Weak Balance Sheet

Total unrestricted cash and investments at Sept. 30, 2013 for the medical center was $243 million, which translated to 78 days cash on hand and 55% cash to debt compared to the 'BBB' category medians of 144.7 and 91.7%, respectively. LLUMC has a 60 days cash on hand covenant.

Significant Use of Note Payables and Capital Leases

Total outstanding debt for the system was $541 million in fiscal 2012 and includes $353 million of bonded debt and $188 million of notes and capital leases. The significant use of note payables and capital leases creates a front loaded aggregate debt structure with MADS of $55.6 million in 2013.

Of the bonded debt, $105 million is variable rate and $40 million were VRDBs that were converted to a direct bank loan (Union Bank) with an initial term of seven years. The remaining $65 million of VRDBs are supported by two LOCs from Bank of America ($40 million series 2007B2 and $25 million series 2008B) and these bonds are also in the process of being converted to a direct bank loan. The current expiration of the series 2007B-2 LOC is November 2013 and for the series 2008, November 2014. LLUMC has two fixed payor swaps for a total notional amount of $100 million, which required collateral posting of $23 million as of Oct. 16, 2013.

Debt service coverage by operating EBITDA is adequate for the rating level at 2.5x in fiscal 2012 compared to 3.1x in fiscal 2011 and the 'BBB' category median of 2.7x. Through the nine months ended Sept. 30, 2013, coverage was 2.9x for the medical center only. Debt service coverage should not be affected and could improve with the REIT buyout as there should be cash flow savings from the operating lease expense versus debt service for the financing.

Disclosure

LLUMC covenants to provide annual audited and quarterly information for the OG to bondholders. Quarterly information, including a balance sheet, income statement, and statement of changes in net assets will be provided within 60 days after the end of each of the first three fiscal quarters.

Outstanding Debt

--$70,000,000 Loma Linda, CA hospital revenue bonds (Loma Linda University Medical Center), series 2008A;

--$25,000,000 Loma Linda, CA hospital variable rate revenue bonds (Loma Linda University Medical Center), series 2008B (bonds supported by letter of credit (LOC) from Bank of America);

--$40,000,000 Loma Linda (CA) (Loma Linda University Medical Center Project) variable rate hospital revenue bonds, series 2007B-1

--$40,000,000 Loma Linda (CA) (Loma Linda University Medical Center Project) variable rate hospital revenue bonds series 2007B-2 (bonds supported by LOC from Bank of America);

--$148,354,187 Loma Linda (CA) (Loma Linda University Medical Center Project) hospital revenue refunding bonds, series 2005A;

--$17,045,000 Loma Linda (CA) (Loma Linda University Medical Center Project) hospital revenue refunding bonds, series 1999A.

Additional information is available at 'www.fitchratings.com'.

Applicable Criteria and Related Research:

--'Nonprofit Hospitals and Health Systems Rating Criteria', dated May 20, 2013.

Applicable Criteria and Related Research:

U.S. Nonprofit Hospitals and Health Systems Rating Criteria

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=708361

Additional Disclosure

Solicitation Status

http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=805900

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